Thursday, August 08, 2013

Conservative economic arguments since the crisis: A review

If you ever find yourself thinking "Wow, my side has all the smart arguments, and the opposition is talking nonsense", watch out! You are probably suffering from "myside bias", which is a far nastier and more irrational cousin of derp.

So when I think to myself "Gosh, the right has deployed one specious argument after another since the 2008 crisis", I instantly suspect myself of suffering from this pernicious endemic mental disease. So to try to ward off confirmation bias, I want to go through the main economic arguments put forth by conservatives since the crisis, and try to be as fair and even-handed as I can to each. Maybe that's a hopeless task, but it's healthy to do these things once in a while.

Background: This has become almost an article of faith within conservative circles. The political motivation for believing this is clear - "It wasn't the captains of industry that screwed up, it was the government, those meddling socialists, and the irresponsible minorities they're always handing money to!" is a tempting argument. I find that if I have discussions with conservative friends about the crisis, they insist as a prerequisite for continued discussion that I apportion at least some of the blame to govt. affordable housing policies. Kind of like when you're fighting with a family member, and they insist that you take at least some of the blame, in order to let them save face. "We were both wrong, now let's hug and make up."

Evaluation: It is probably the case that affordable housing policies led to some people getting homes who couldn't afford them. Then again, maybe not. The CRA dates from the 70s, and Fannie and Freddie have been pushing affordable housing since at least the 90s, but house price/income ratios were pretty steady until 2000, at which point they took off. So it seems possible that affordable housing policy really didn't do all that much til the 00s.

But regardless, the idea that affordable housing policy caused big banks to collapse seems obviously wrong. Suppose it was govt. policy driving the lowering of mortgage standards. Why didn't banks realize this and adjust their expected default rates accordingly? There's no good reason. Conservatives are essentially arguing that without government policy, banks' crappy risk management and crappy due diligence would not have had big negative consequences. Some excuse!!

Anyway, as anyone familiar with the crisis knows, one fatal assumption in banks' risk models was the backward-looking assumption of constant correlations. That's not an assumption that depends on government housing policy one way or another.

OK, but what about banks' other key fatal assumption: That historical default rates would be constant? By encouraging lenders to lend cheaply to unworthy borrowers, couldn't Fannie and Freddie and the CRA have made default rates spike? Well, in theory, sure! But in practice, it's worth asking why this did not happen in 1985, or 1995, or even in 2002. We had Fannie, Freddie, and the CRA back then. And default rates did not suddenly spike until the housing bubble burst in 2006-7.

So did government policy cause the housing bubble itself? Answer: No. Because a lot of other countries had simultaneous and even larger housing bubbles, and those countries did not have Fannie, Freddie, or a CRA. Also, it would be odd if Fannie, Freddie, and the CRA were benign for decades and then suddenly caused a giant bubble.

Also, Mike Konczal and others have made other arguments against the "affordable housing caused the crisis" argument. These arguments are reasonably convincing.

However, it does seem true that Fannie and Freddie got themselves into quite a bit of trouble in the housing bubble, and that the brief specter of their failure (before they were formally nationalized) raised risk, hurt liquidity, and probably made the crisis worse than it otherwise would have been, in addition to costing the U.S. taxpayer a big chunk of money (though they may soon finish paying that money back).

Conclusion: I judge this conservative argument to be 5% right.

Argument 2: "Stimulus can't possibly work."

Background: When fiscal stimulus was first mooted, a number of conservative-leaning economists came out and said "Stimulus can't work, because it's just moving demand from one part of the economy to another." This was basically the "Treasury View" expressed during the Great Depression. However, conservatives seemed to stop saying this fairly rapidly after the initial burst of anti-stimulus mania.

Evaluation: There were theories that said otherwise, of course, that could not be dismissed easily. As John Cochrane, himself a noted stimulus skeptic, wrote in early 2012:

Stimulus [is] still an economically interesting proposition, and there is a great deal of uncertainty about whether, when, and how well it might work. There is a huge academic literature being produced right now...

Here are the facts. Some economic models do predict a fiscal stimulus effect. Some don't...The facts are far from decisive...So, there is a lot of uncertainty and a lot we don't know about how the macroeconomy works.

I would agree with that statement. There is evidence that stimulus works; there is evidence that stimulus does not work. There are theories on both sides of the question. And since macro data are uninformative, the argument won't be resolved soon.

But note: A common conservative argument in 2009 wasn't that stimulus doesn't work, it was that stimulus absolutely can't work, and that this fact is obvious from simple logic. As Cochrane notes, that just isn't true.

Conclusion: I judge this conservative argument to be 0% right.

Argument 3: "Welfare is the main force prolonging the recession, by discouraging people from working."

Background: This argument - that the spike in unemployment is a "Great Vacation" - has been promoted by a substantial minority of conservatives. Casey Mulligan has been the chief standard-bearer of this argument. It has also been propounded by Nicholas Eberstadt.

Evaluation: This argument basically says that a big chunk of the increased unemployment in America is voluntary. That is inconsistent with the fall in wages during the acute part of the recession. It is also inconsistent with the slow wage growth since then. It is also somewhat inconsistent with the fact that there is a big drop in satisfaction between people who kept their jobs and people who lost theirs; if the newly unemployed were on a "Great Vacation", then they should be close to indifferent between keeping their jobs and losing their jobs.

It also seems highly unlikely that similar shifts in welfare policies happened simultaneously all over the developed world. And yet the sharp recession and slow recovery looked very similar all over the developed world. That just does not fit Mulligan's theory.

That said, however, the number of people claiming Social Security Disability benefits does indeed look fishy. It seems likely that in the absence of this program, some of these people would be forced to find work, however low-paid and unfulfilling annd unpleasant.

Conclusion: I judge this conservative argument to be 10% right.

Argument 4: "Fear of liberal policy interventionism is the main thing holding back the recovery."

Background: This was the main conservative thesis about the cause of the slow recovery, and remains such. The argument was that fear of Obama's socialist policies, including Obamacare's negative impact on business and Obama's personal rhetorical attacks against the business class, were spooking businesspeople into holding back investment.

The assertion seemed to get a boost in 2011 from a paper by Scott Baker, Nick Bloom, and Steven Davis. These professors constructed an index of economic policy uncertainty by counting newspaper articles that seemed to discuss policy uncertainty. They found that their measure of policy uncertainty was correlated with slow growth.

Evaluation: The paper by Baker, Bloom, and Davis is credible. Nick Bloom in particular is someone I know, admire, and trust, and I find it highly unlikely that he would suffer from political bias. However, even though the authors were careful, strong conclusions should not be drawn from this methodology. There is the issue of causation, as Mike Konczal points out:

As commenters pointed out, it would be easy to construct an index that gets the causation to be spurious or even go the other way. If weak growth could cause the Economic Policy Uncertainty index to skyrocket, then it’s not clear the narrative holds up as well. “There’s uncertainty over whether or not Congress and the Federal Reserve will aggressively fight the downturn” isn’t what the index is trying to measure, but that’s what it seems to be doing.

Also, the Policy Uncertainty Index doesn't appear to be performing as well out of sample as it did in sample. That is, of course, entirely typical for macro forecasting tools.

Additionally, the data do not seem to support the conservative argument that policy uncertainty has been driven by Obama and the Left. The largest identifiable sources of spikes in Baker, Bloom, and Davis' index have been caused by the Republicans' 2011 debt ceiling brinksmanship, Europe, and efforts to sue Obamacare out of existence. There really is no evidence of all that fear of Obama's antagonistic attitude toward business is pushing up uncertainty.

Finally, there is the international element. The slow recovery all over the developed world may indeed correlate with policy uncertainty in each developed country. But given the diversity of policy regimes, that suggests that uncertainty is an effect of recession more than a cause. Still, the U.S. is a very large and important country, and U.S. policy may be driving the economies of other countries (though personally I'd bet on Europe being the biggest source of policy uncertainty).

Conclusion: I judge this conservative argument to be 15% right.

Argument 5: "Quantitative Easing will cause inflation."

Background: Read the WSJ, and you see this repeated over and over. A number of famous economists have added their voices to the chorus.

Evaluation: The notion that printing money causes inflation is a centerpiece of a lot of economic theories, especially "old monetarist" theories in the tradition of Milton Friedman.

However, the failure of inflation to materialize in response to QE has left conservative inflation hawks looking a little bit like flat-earthers. A number, like Larry Kudlow, have reversed their positions and no longer fear inflation from QE.

However, there is always the possibility that one day inflation will suddenly "snap up" to high levels, as a delayed result of QE. Since humanities understanding of macroeconomics is so limited, this can't be ruled out, even given Japan's decades-long deflationary experience. There is always the unknown.

Conclusion: I judge this conservative argument to be 10% right.

Argument 6: "Deficits are dangerous and must be cut, but only by cutting spending rather than raising taxes."

Background: This is a little rich coming from conservatives, whose tax cuts drove essentially all of the rise in deficits from 1980 through 2008. But it is a common refrain for them, even when they can't identify any concrete things to cut other than Social Security, Medicare, and Medicaid (which they are usually afraid to admit openly that they want to cut). The conservative case against debt received help from Reinhart and Rogoff's now-discredited paper about a 90% debt-to-GDP "threshold".

Evaluation: Is government debt bad for an economy? There are theoretical reasons to think that it is, in normal times, especially for a country whose debt is not entirely internal, such as the U.S. Debt carries over from recessions into normal times. And it is often politically difficult to do the right thing and run surpluses during boom times (Clinton managed to do it, just barely, but it is a rare feat). Governments and people get addicted to low tax rates and to government transfers. Additionally, there is the precautionary principle. We may need to spend money on some other catastrophe - a war, or another recession sparked by a European or Chinese collapse. It would be useful to prepare for such an event by reducing the debt/GDP ratio beyond what would be reasonable if we were certain of a smooth return to trend growth.

Of course these considerations should be weighed against the obvious short-term economic harm of deficit reduction. "Austerity" has hurt the economy of every country that tried it, and may be hurting the U.S. now, as the "sequester" bites into government spending. Still, even without the sequester, U.S. policymakers have acted to set the country on a path to lower long-term deficits, and people in general seem to be relieved about that. It is probably the case that a middle path on deficits is the wisest one. The infrastructure spending we need to be doing could be financed by tax hikes and cuts in transfers, to the benefit of all.

Conclusion: I judge this conservative argument to be 50% right.

(Update: The second part of that argument - that spending cuts are OK while tax hikes are not OK - is wrong. So the 50% figure should just be applied to the "deficits should be cut" part, since it seems to me that deficits probably should be cut for the long-term, just not too quickly to choke off recovery. With the "spending cuts but no tax increases" part included, I knock it down to 15% right.)

To sum up, as hard as I try, I can't rid myself of the notion that conservatives have tossed out a lot of bad economic arguments in the last five years. It seems to me mostly a defensive reaction. The 2008 crisis put everything in American politics and political economy in flux, and conservatives desperately wanted to avoid a general turning of public opinion against the business class. Now that that looks unlikely, conservative writers and intellectuals are making somewhat fewer obviously specious economic arguments (Republican politicians, of course, are another matter). Notice that I said "somewhat".

Of course, this is not to say that liberals have had nothing but good economic arguments since 2008. But being on the offensive rather than the defensive, they have had a lot more ideas. And my fingers are getting tired, so I'll avoid tackling that list today...

114 comments:

I'm surprised you didn't go after the "easy money = drugs" meme that has been so popular lately. I mean of course the proposition that the fed's loose money policy was singularly the cause of irresponsible lending.

"That said, however, the number of people claiming Social Security Disability benefits does indeed look fishy. It seems likely that in the absence of this program, some of these people would be forced to find work, however low-paid and unfulfilling annd unpleasant."

BTW, this program is not easy to get into; it's just as likely that disabled people were working until the economy crashed.

I would expect disabled people to find it very, very hard to get a job in a bad economy.

BTW, on the deficit, not only did these guys *cause* most of the deficit and debt, they were definitely not yelping as loud when it was their guy doing it (I'm looking at your, Gregory 'no comments on my blog, 'cause I lost arguments' Mankiw).

Re: disability, the story that makes sense to me is that "disabled" people may have lost decent desk jobs and the only jobs now available are service sector jobs requiring a lot of lifting and standing, which they're unable to do, making them now, but not previously, "disabled."

Fortunately, BLS publishes data on employment of the disabled. Among the disabled, employment is down 16% (one out of six) since the recession. For workers without disabilities, employment has fallen 0.8%. SS Disability acceptance didn't get easier; it just became more necessary for those with disabilities.

I do have something to say about the people who are applying for disability. The reason is, I know a lot of them. I am a psychiatrist working in rural health clinics in southern New Mexico (which is he poor part of a poor state.)Of course my sample is biased, which is why I give a snapshot of the sample. My impression of the typical disability applicant is this: high school education or less, divorced, overweight, diabetic, with arthritis, maybe COPD, maybe back pain, sometimes with obstructive sleep apnea. Most are in their 50s or early 60s. They are living with relatives, or perhaps in a disused RV or trailer in the back of a friend's property. Many have told me that they are applying for disability because they need insurance. They can get basic care in our clinic, but they need to see specialists to get the care they really need. Most were probably marginally productive before they lost their jobs in the crisis. All the ones I see have either anxiety or depression, but not to a disabling extent. They used to work in construction as unskilled laborers, or in agriculture, food service, landscaping, or as housekeepers. I can imagine some jobs that these people could get, but (1) they would not get insurance, and (2) there are not many of those jobs available. Walmart only needs a few greeters. There are only a couple of slots for cashiers in florist shops. A lot of these people live in agricultural communities, and they cannot work in the fields, they cannot sling 50-pound bags of pecans, onions, or chiles. There are a few people who can sit and pick out the bad produce as it goes by on the conveyor, but those jobs are seasonal, intermittent.

Ironically, I have seen some of these people who set out to find work, but they can only work four hours a day, so they want to work part-time. Yet when they got their jobs, they were pressured to put in more hours. They get discouraged and feel degraded when they face this pressure. Meanwhile, I see young working people who would gladly work more hours, but are never given the chance.

I don't really think "forced to find work" is a thing. You can't just magically conjure up work where there isn't any. Nor do people really need to be forced.

Most people view government assistance as a last resort, beyond even relying on family and friends for aid, and so a rise in disability applications seems to me to be wholly consistent with a rise in unemployment. More desperate people means more people with no choice but to seek aid.

I would like to see a methodologically rigorous examination of whether disability standards have loosened. If they have not, there's no evidence for an incentive effect.

I have another idea is are there more people with more experience that are now unemployed because they get hired first before people with maybe a developmental disability and do not have as much experience and companies prefer workers with more experience. I think the expirence of unemployed person may have rose over what it otherwise would have been.

The arguments were contested at the time, and eventually debunked. But it doesn't matter. We can't understand these arguments on a right-wrong axis. Look rather at supply and demand. The Republican Party demanded arguments against whatever it was the president was doing. So the arguments were supplied, by AEI, Hoover, etc. Evaluating them years later, as empirical assertions rather than statements of tribal solidarity and propaganda useful at the time, quite misses the point.

You are missing the point. Look up the "Overton Window" in wikipedia. Or read Ron Susskind's interview with Bush administration officials in which they ridicule the "reality community". The whole point of conservative "thought" is to mock reality. When Ann Coulter published a book rife with footnotes, people who checked those footnotes found them spurious or actually counter to her point. Thinking these arguments are rational makes you a sucker: they are Rationalist, meaning they deny the relevance of empirical fact.

While it's always good policy to be skeptical of your own strong priors, you are being far too kind to the conservatives. You are a gentleman, and polite to a fault, and just can't bring your self to give conservatives the thorough thrashing they so richly deserve.

1) F and F possibly maybe kinda sorts making the crisis a tiny bit worse is not the same as causing it. The conservative argument is 0% right.

3) How significant is fishy SS disability benefits in the grand picture of welfare --> great vacation? Can it possibly be as high as 10%? How about something in the range of 1%?

4) The conservative argument relates specifically and exactly to BHO's alleged hostility to business. Republican debt brinksmanship is not part of their narrative. Given your other cogent arguments, how can you give the conservative position 15% right? No part of it is convincing, and everything about it is tenuous and speculative. I think 5% right is extremely generous.

5) Here you are making the same mistake that politifact is being so roundly and deservedly criticized for, just this very week. The fact that something might just possibly happen at some uncertain date does not justify calling the statement partially correct what it so clearly and obviously wrong right now. And has been consistently so for 4 years. The conservative argument is 0% right.

6) Nothing is your text comes even close to supporting a 50% right assessment. Clearly this conservative position is pure republican hypocrisy. It is too low on an intellectual scale to even qualify as derp. We have run deficits almost continuously since the founding of this country. Reagan and Bush II account for the vast majority of the pre-crisis total. The conservative argument is pure partisan nonsense, and only exists to justify the destruction of the tattered remains of the new deal, which they have always hated. I'll be extremely generous and give it 10%.

You're inconsistent in the way you word the conservative position and then the % you assign to it. Let's take your 2 and 3 as examples:

(2) You judge this as 0% because you worded it in an extremely absolutist fashion.

(3) You judge this only as 10% right, even though the way you worded it means that it should be 100% true if there were any effect at all using the strict logic you applied in (2).

If you choose to use % as a metric, you should probably apply it to the degree of truth to the underlying position, not a particular wording of that position. Under this scheme, I would say (2) is about 75% true--fiscal stimulus helped some but not a lot--and (3) is about 25% true--work disincentives are there but not the main issue.

As a quibble, I think (5) is poorly posed. Liberals who think QE works mostly believe that it should cause inflation too, but that it will affect RGDP more. There are actually three positions here. The conservative position which is that QE will cause much more inflation than RGDP growth, the liberal position which is the opposite, and those that believe QE won't effect either variable very much. Under this characterization, conservatives are in fact close to 0% right. But it's not clear that liberals who believe in QE are 100% right either.

3) I'm trying to make sense of this, but it is escaping me. The Great Vacation idea was nonsense when the Austrians proposed it in the 30's, because it was the only way to vindicate their theoretical position. It's still nonsense now. Comparing the point 3 wording to the point 2 wording in Noah's text is a red herring.

Then you go on to apply your own strong priors, rather than looking at what has actually happened.

Jazzbumpa, I wasn't objecting to the absolutism, I was objecting to the inconsistency, which Noah acknowledged. So much for "derp" on that front.

Also Jazzbumpa, apparently you are confused about the concept of "strong priors". The guy with posteriors of 75% and 25% is far more likely to have had _weak_ priors than the guy with a posterior of 0%.

It's funny that you accuse me of derp when my number on (4) is 25% vs Noah's 10%. That's pretty close all things considered. So clearly, I am not completely unwilling to update my priors.

And my 75% vs Noah's 0% on (3) was stated as assuming a less absolutist wording. Given the absolutist wording, I would put it at 15%. Again, pretty close.

Ironically, accusing people of derp when they clearly updated to a position fairly close to yours is itself derp. Or perhaps "meta-derp"

The strength of priors doesn't come from a percentage distribution on some spectrum, but how deeply they are held.

Re: no 4, I don't know of any real evidence that the alleged uncertainty of gov't policy is directly causal to anything, [the real primary factor being a lack of aggregate demand] nor that it is due to BHO making CEOs cry. So 25% still looks pretty derpy to me.

Percentages aside,I don't believe that our positions are close at all. But I've ever been accused of being "meta" before that I can recall, so thanks for the acknowledgement.

The CRA was essentially replaced in 1995, but the most toxic of the housing loans were made after the 2003 refi boom. Noah's original point still stands: the timing of the change in the CRA is not consistent with the timing of the housing boom.

Thanks Eric. You didn't read the article, but at least you're trying harder than Noah.

"That’s still too early. Why would changes in the mid-nineties result in a mortgage boom a decade later?Throughout the nineties, as banks lowered their mortgage standards, mortgage rates remained high. The laxity was spreading but the incentives for borrowers to re-finance even under relaxed standards remained low. New buyers often still didn’t know that some of the loosey-goosey mortgages existed. Speculators had an internet bubble, so they weren’t yet attracted to real-estate. Treasury rates were not yet so low that investors seeking yield would pour into mortgage backed securities. Securitization levels were low enough that banks weren’t yet willing to fully embrace the loose standards. The historical data on default and loss rates from the lax lending were not yet available, so they weren’t embraced by banks or the broader market.

But as the years went by, these factors changed. The Fed pushed interest rates down. This made refinancing more attractive, and created an investor demand for yield. Fannie and Freddie popularized low-income securitization. Low defaults and loss rates from lax loans made them seem not as risky as previously expected. A shrinking consumer asset base thanks to the dot com bust created a demand for home-equity loans and high loan-to-value loans, as consumers exchanged high-interest credit card debt for low interest home debt. Speculators seeking higher returns and ordinary home buyers became aware that lax lending standards would allow them to buy bigger homes with little or no money down.

In short, the lax lending standards created in response to the CRA had dug a pit that was waiting to get filled when the circumstances were right."

Tell you what: retitle the post "Conservative economic arguments since the crisis: A caricature written to garner approval from Paul Krugman" and we'll call it even. :)

I'm aware of the argument that the CRA is responsible for the housing boom from other sources than the article you mentioned. Hans-Werner Sinn has a version in his book, Casino Capitalism.

I'm more disposed to see the decline in lending standards as part of the usually beneficial process of financial innovation: the rise of automated underwriting and shadow banking to meet a demand for mortgage credit in profitable ways. The CRA is not a necessary part of the story, since if what I've read about the testimony of Federal Reserve and former Treasury officials is true, that they say most subprime loans were made by insitituions that were not covered by the CRA at all, or that were only partially covered as subsidiaries of regulated institutions, then standards were not lowered because of the CRA, but fell naturally as it looked like credit could be extended profitably to more marginal borrowers.

I guess the odd thing is this: suppose the CRA loosened standards as much as its critics claim. Why didn't lending institutions accurately price in this risk when constructing the mortgage product? A confluence of factors seems to have led risk to be mispriced, call it the great moderation, but I'm really thinking about a bond bubble. This was world wide. If I recall correctly something I read from Alan Blinder's recent book, Columbia issued debt that offered a yield only 100 basis points more than US Treasury debt of the same maturity.

Basically, credits all over looked safer than they were. Not just homeowners, and I think throwing the CRA into the mix doesn't do much to try to explain why that was the case.

Perhaps you will be more intellectually honest in your "more interesting things"?

And further, you can go away, but the misleading implications you want to leave here for posterity still look inane to those who have looked at both your link and the facts. The idea that the CRA and the other factors creating "demand for yield" *forced* private lenders and private securitizers and private investors into bad loans and bad securitizations and bad securities simply doesn't make sense, no matter how much gobbledygook he throws up in his weak charade of answering objections in that piece.

After what has happened the last five years, you seriously want us to take at face value an argument that the banks do something they don't want to do in response to regulation and government meddling? This is preposterous. Look, I want to be polite, but the argument is *preposterous*.

Listen, that guy can say all he wants that the CRA was "necessary, although not sufficient" to cause the crisis, but that doesn't mean that he actually proved that it was "necessary". In fact, if you know anything about logic, you would know that it would be impossible to prove that it was "necessary". You would have to prove that no other hypothetical combinations of factors could *ever* lead to this kind of crisis.

You can keep repeating things that don't make sense. Please, go on. And we will continue to not change our minds when your statements, no matter how oft repeated, continue to make no sense.

Such utterly weak minds who desperately cling to the weakest arguments because they are so frightened of the possibilities and uncertainty in the world.

It is correct that there was a major change in CRA-related policies to encourage more minority lending in 95, and it is also the case that the price/rent ratio began to rise in 1998, only three years later, not 2000 as Noah claims. Furthermore, it is also true that many of the people with low incomes (particularly Hispanics getting flakey mortgages near the end of the bubble) were disproportionately among those failing to make their payments and going bellyup.

That said, Noah's argument about foreign housing bubbles remains relevant, and it is also the case, unmentioned by anybody so far, that the largest increases in housing prices were for higher priced houses than for lower priced ones. The owners of lower priced houses may have experienced greater financial trouble when the bubble burst, but their purchases did not drive the bubble, which came from the top on down.

"This is just bad thinking. Did revenue decline from 1980 to 2008? Was spending constant?"

Revenue as a % of GDP has fluctuated considerably since the the 80's, where the most honourable derp presidents Ronuldus Reagan and Dubya commenced macro experiments in Napkin-Drawings Economics (proles don't get it).

That kind of vitriol has no place in academics or any formof serious intellectual inquiry.

On the contrary. Before you can have a serious intellectual inquiry you have to identify those who are prepared to play by the rules of rational discourse and those who are not. I am not prepared to engage with people who look me in the eye and start spouting right wing talking point nonsense. The right wing hacks and mouth breathers need to be asked to leave the room so the grown-ups can talk. (And no, I don't have a "Co-exist" sticker on my car and I don't post ecards on Facebook. )

By the way, Davyde, you might want to look up 'ad hominem' in your dictionary.

What he was doing was more or less the exact opposite of an ad hominem attack. He was saying, 'if you make this fallacious argument, I know that you are the kind of person with whom I should not waste my time'. Whereas an ad hominem attack says, 'because you are a low and base type of person, nobody should listen to your arguments'.

But it's okay. Most people think 'you are an asshat' is an ad hominem attack, so at least you're not the only one making that mistake.

SS benefits may prolong unemployment, but that is not at all the same as prolonging the recession. In fact, isn't it just as likely that demand is increased so long as all the jobs are filled, or filled such that the SS is adding income to the economy?

Zach, you beat me to the point I was going to make. Precisely. For SSI to create a drag on the economy, it would have to be the case that the jobs not being taken by recipients were going unfilled and therefore production was going down. In the context of persistently high unemployment, that's clearly not the case. The jobs SSI recipients aren't taking have been taken by other low-skilled job seekers, a significant number of whom would themselves be unemployed in the alternate universe where SSI benefits weren't going to marginally disabled individuals.

What about NGDP targeting and the contention that monetary policy can be effective around the ZLB? I know it's only a small fraction of conservatives who buy into the MM critique that the Fed has failed at its task and needs to step on the gas, but Josh Barro and Scott Sumner are worth listening to, whereas pointing out that Austrians have issues with empirical truth is like pointing out that water is wet.

Most conservative arguments are wrong because they are arguing for pro-cyclical policy when the economy is operating below capacity. Whether they are arguing this because they genuinely don't believe in idle capacity/demand shortfalls, or because they want the economy to be bad while the Kenyan Muslim Socialist Usurper is in power I don't know. Yeah, Barro and Sumner are fairly heterodox, but the MM take is at least nominally (ha!) conservative and worth the effort of spending brain waves on. If someone wants to make sure they aren't suffering from myside bias, they should look at arguments that are worthwhile, and not just the sludge pumped out by the WSJ editorial board. Of course, it's not my blog, and maybe I just love the Smith-Sumner blogwars a little too much.

Poor Wildcats. So what you're saying is, if one side is actually wrong more often than the other, it is always bias to point that out? Or are you just saying that *SINCE* the conservative argument is always correct, it is bias to point out that the conservative argument is generally wrong?

The fact that a poor argument exists in the world in favor of a particular supposition does not in fact make that supposition any less likely to be true.

I think that in a some sense there was only one argument actually being made. For those familiar with A.O. Hirschman's classification of reactionary rhetoric it is a kind of hybrid perversity-futility-jeopardy argument.

The first part of the meta argument being that all attempts at economic policy making lead inevitably to perverse outcomes. This argument is both easy to make, notable when made, likely to convince people and completely illogical–especially when faced with a genuine crisis. "Do nothing to react to the obvious funnel cloud in your rear view mirror. That is not a tornado its just a little windy. Keep driving the speed limit and don't worry about it." (Arguments 1,3,5,)

The second part of the meta argument is that actions won't have any intended consequences because all of the policy tools that we have are actually ineffectual, and obviously only the marketplace and time can really change things. (Argument 2)

The third part of this meta-argument is that any attempt to change things will ruin this perfectly fine and functional system we got right here (this is kind of a brazen argument at the moment but it still gets thrown around.) (Argument 4)

FInally argument six has is a radical argument not a reactionary or conservative argument. it is basically a form of libertarian extremism. As such it is actually susceptible to the other arguments described above. Disregarding traditional monetary and fiscal tools is likely to lead to perverse outcomes, or change nothing and it will break down the highly successful economic compromises that we have made for the past 80 years.

Kudos for questioning your bias and trying to dig in deeper. Major minus points for not actually turning off your biases as you evaluated the opposing arguments. You didn't make an ATTEMPT to do so. On the whole I'd call it a net negative.

The last 50% isn't that credible, though I could see arguing against debt on the basis that it allows China to avoid necessary rebalancing. The sad part of this is some conservatives arguing that monetary rather than fiscal policy should be used, but then not arguing for it or supporting it. The conservative position was liquidate, liquidate, liquidate.

Getting SSDI takes a huge effort -- according to the Social Security Administration, only 28% of initial claims are approved, and even with appeals, the final number approved is still less than 50%. The process can take years.

Saying "it seems likely that in the absence of this program, some of these people would be forced to find work" strikes me as wrong, given the paucity of jobs and the likelihood that employers will avoid hiring anyone who seems remotely disabled. It's more likely that if the program didn't exist, these folks would have nothing at all.

Given your analysis, the paper by Baker, Bloom, and Davis is not at all credible, for two reasons:

1) It was apparently based on newspaper articles mentioning "uncertainty" which brings up a problem of a self-fulfilling prophecy. If conservatives are loudly claiming that the poor economy is caused by uncertainty, there will be newspaper articles on that subject. To then claim that the poor economy was caused by uncertainty because people were writing articles speculating on one side's talking points is at best circular reasoning.

2) You note: "Also, the Policy Uncertainty Index doesn't appear to be performing as well out of sample as it did in sample. That is, of course, entirely typical for macro forecasting tools." What this says is that macro forecasting tools are worthless. Anyone can construct a hypothesis to explain a set of data that they have gathered - to test the hypothesis, one makes a prediction based on the hypothesis (hopefully with a null hypothesis to test whether the hypothesis is not correct) It is the ability to generate accurate predictions that renders a hypothesis useful. Otherwise, it is merely useless 20:20 hindsight. If macro forecasting tools typically can't forecast accurately, they are typically worthless.

Anyone can take the data from 2 years ago and make up a rationale for the events of the previous year - the trick is to then be able to predict what will happen in the future.

Noah - what are you playing at? Argument 6 is absolutely false from a macroeconomic perspective. A much better use of your time would have been to take these so called "conservative" propaganda memes and actually analyze them from a macroeconomic perspective. I'm thinking that you could propose credible causation mechanisms and analyze the likelihood using models and relevant current data etc. Maybe next time.

You gave 10% weight to argument 5 "Quantitative Easing will cause inflation". I would give to it 90%. To much money printed will certainly cause degradation of Money value. Yet why it doesn't happens now? 1. The printed money is withdrawn from the circulation, as the commercial banks keep double reserve rate, than demanded by the Fed. 2. to much money printed doesn't cause inflation when the production capacities are unemployed, and this is exactly what is happening to the US economy now. 3. The third reason why the QE doesn't cause inflation is the loans the economies external to US give to the US.

But what if just one of the parameters changes drastically? The reserve money can in one day go back to the credit system. what then? Probably the Fed will have to increase in this case one of the requirements from the bank. Basel 3+++.But the main problem will be if the unemployed production capacity will be exhausted and it doesn't have to be necessarily unemployed work force. It can be one or several major commodities, (actually it is happening except with the energy, due to the fraction). And i even don't dare to ask the last question what will happen to the US and then to world economy if all the net exporting countries will stop to purchase US government bonds or reinvest their surpluses to the US economy.

Very nice piece.1. Have you seen Calomiris' account of the pressure put on risk management practices in FM and FM? I found it quite compelling, although I haven't read around to pick up whether there is another side to the story.2. Even if the agencies weren't the sole cause, they were surely a contributory factor.3. I think it's harsh to say that the macro literature are totally uninformative. Apart from the crazies, most people believe that at the zero bound an exogenous fiscal stimulus, is, well, stimulative.4. Baker, Bloom et al did try to deal with the causality issue by identifying shocks. Whether that's successful or not is debatable, but they had a go.

How you can go thru the first five so nicely and then launch into brain freeze when the word debt comes up is beyond me. Federal debt is nothing more than the promise of future tax relief. If you have federal debt, i.e., if you have money. you can pay your taxes. It's nothing more than that. Stop making it more complicated than it is.

(Btw, in his response essay, Brad DeLong wrote: "Larry White is the best of the Austrians — the most persuasive, the most thoughtful, and the most knowledgeable of the economists working in the Austrian monetary theory tradition, which is an essential part of our collective diversified intellectual portfolio" Just sayin'.)

You wrote: Also, it would be odd if Fannie, Freddie, and the CRA were benign for decades and then suddenly caused a giant bubble.

In another paper, Larry White lists some important changes in the CRA made in the 90s.

"Further amendments in 1995 gave the CRA serious teeth: regulators could now deny a bank with a low CRA rating approval to merge with another bank—at a time when thearrival of interstate banking made such approvals especially valuable—or even to open new branches."

Changes were also made that affected Fannie & Freddie:

"For 1996, HUD required that 12 percent of allmortgage purchases by Fannie andFreddiebe 'special affordable' loans,typically to borrowers with income less than 60% of their area’smedian income. That number was increased to 20% in2000 and 22% in 2005. The 2008 goal was to be 28%."

And in this Congressional testimony, Lawrence J. White (from NYU, not the Austrian Larry White) described the many advantages that allowed Fannie/Freddie to grow so rapidly in the 90s. Looking at Table 1, you can see how the GSEs became dominant players in the mortgage market in the late 90s, reaching 40% by 1999 (from 25% in 1990).

One could reasonably argue that the mortgage market distortions caused by Fannie, Freddie, and the CRA didn't really kick in until turbocharged by the Fed's low int rates of the early 2000s, particularly its depressing of short-term rates. Larry White again:

"Back in 2001, nonteaser ARM rates on average were 113 basis points cheaper than 30-year-fixed mortgage rates (5.84 percent vs. 6.97 percent). By 2004, as a result of the ultra-low federal funds rate, the gap had grown to 194 basis points (3.90 percent vs. 5.84 percent)... The share of new mortgages with adjustable rates, only one-fifth in 2001, had more than doubled by 2004."

"Many borrowers who took out ARMs implicitly (and imprudently) relied on the Fed to keep short-term rates low for as long as they kept the mortgage."

One well-worn criticism of Austrian Business Cycle Theory is essentially that it assumes that only idiots are fooled by central bank manipulation of nominal rates. But how were these borrowers supposed to know that short term rates would rise sharply a few years down the road?

Not only is the general public unable to predict the future path of short term rates (who can do that?); according to Robert Shiller, most people don't even understand the concept of the "real interest rate." He writes:

"The real interest rate concept still seems highly relevant in judging the high asset prices we observe, but the public won’t buy it. I know this from personal experience, when I talk with news reporters and attempt to refer to the concept. They listen patiently and change the subject, and sometimes even offer that their readers don’t relate to such a concept."

http://cowles.econ.yale.edu/P/cd/d16a/d1632.pdf

Small wonder few borrowers cared (or were aware) that real rates were way below average, and even negative, throughout the boom years.

You're giving these arguments too much credit. 5%, 10%, 50%! Really! Divide all of those by 100 and you're getting somewhere, maybe even the right order of magnitude.

The downturn happened because they are inherent to capitalism. The depth of the downturn and absolutely brutal financial crisis was caused by the gargantuan amount of cross-linked synthetic CDOs. Seriously, the total overbuilt inventory was about 4% of GDP. The economic loss was 93% of GDP. The financial losses were two orders of magnitude greater than the entire overstock of housing inventory. The reason? Because every mortgage loan in the system was bet upon to 40 times the value lent. Half of that had to vanish, and did. When it went, it went fast. There waren't no guns pointed at any CEO to make him do that. They did that shit on their own. CRA, Fannie, Freddie? Pfft. Stupid argument.

As for government debt being bad for the economy, yeah, only if it drives up the general rate of inflation. Taxes can go up or down as necessary to keep inflation in check. In fact, lets be straight up--we've been running deeper public deficits and lower interest rates for the last 30+ years than they did in the 40 years before that. We're just not getting as much out of them in terms of GDP or job creation. We can go all day long about why. I think it comes down to the investing dumbness of rich people, and the inability of non-rich people to form strategic capital. BTW, running surpluses during booms was not unusual at all prior to the Ford Administration.

A shot of inflation would be a damned fine thing, IMHO. The dual mandate is a crap idea. The Good Lord explains it much better than I can: "No man can serve two masters, for either he will love one and hate the other, or else he will hold to the one and despise the other". The Fed cannot love jobs and low inflation, and even so A-men. There's no reason to think the budget can ever reach balance under these conditions. And frankly, no reason to think it should. To those who see the truth of these words I bless with biscuits and gravy and to all the rest I have only three words:

It's a good idea to review the conservative and libertarian positions and how right they've been, but Noah’s not really able, it seems, to make a serious effort to be fair. He’s still got deceptively absolutist restatements of conservative positions even after claiming to have corrected them. Three and four contradict each other.

Once you make realistic representations of conservative positions, they come out mostly right or merely exaggerated.Fannie and Freddie did play big roles in causing the crisis, but mostly because Bush after suppressing them in favor of private securitization, which played a far bigger role, suddenly revived F&F late in the bubble in an effort prop up the floundering private securitization business.

There’s a very strong argument that stimulus does nothing for or even damages long-term GDP growth. Proponents of stimulus duplicitously dodge the argument by refusing to discuss anything other than the immediate effects of fiscal stimulus on current GDP, which are of course positive, and pretending that conservatives don’t know that. What was the first thing Bush did when he glimpsed the crash coming? He dropped helicopter money, hoping to at least forestall it till after the elections.

Everybody agrees that social safety nets and minimum wages to some extent discourage employment. Besides potential employees declining low-wage jobs, employers are discouraged or barred from offering lower-wage jobs. But are we really prepared to cut off social safety nets and let wages drop to wherever they clear? How would people earning the bottom end survive in our high-cost economy? Here conservatives are being dishonest, pretending they want to end welfare when they’re actually part of the consensus compromise that pays people off to sit quietly out of sight in section 8 ghettos.

Conservatives greatly exaggerate how much business worries about regulatory uncertainty because of Obama. A truer statement would be that US regulations are very costly generally and certainly a reason for slower long-term growth rates. Also, there is serious uncertainty over where the costs for ARA will ultimately fall, and Obama and the Democrats are causing that uncertainty with their ridiculously implausible claims that they can extend health coverage to tens of millions of people at practically no extra cost.

The conservative argument that quantitative easing would lead inflation to grow out of control was simply wrong, because what little effect QE seems to have had on private spending has been outweighed since 2011 by Republican action on public spending.

Deficits are dangerous, and more to the point the very big deficits of 2009-2010 heading into the start of boomer retirement in 2012 were indeed alarming. Austerity hurts but getting inevitable austerity behind you helps. Frankly the news has been quite good since 2011. The compromise reached in the 2011 political crisis has worked very well at bringing down the deficit to far less dangerous levels, without snuffing out growth as the fiscal-cliff scaremongers assured us it would. The best part of it is that such a large portion of the cuts are coming out of defense spending, something I never expected given how easily the defense industry usually gets its way in Congress. The sequesters were a big stroke of luck and we should be grateful for them. Obama’s attempt to turn them into a campaign issue was outrageously dumb.

Finally Noah missed another important conservative position, or more precisely libertarian position: that the Fed’s accommodative monetary policy fueled the bubble and caused the crisis. That’s 100% right and the most important lesson that hasn’t been learned. Despite Minsky’s sudden popularity, his insights about how the credit cycle drives the real business cycle have not been taken on board, neither by policy makers nor by academics. Here the libertarians are basically right: their beloved Austrian theorists after all stated much the same position on the credit cycle as Minsky only decades earlier, differing mainly in their greater emphasis on the central bank versus commercial banks and their religious faith that eliminating the central bank would solve the problem (where I obviously side with Minsky there). But while commercial banks are the real engine of credit bubbles and central banks are usually merely passive enablers, we did in fact have an unusually stimulative central bank in 2002-2004, and that was a very important factor in driving the credit bubble and causing the crash.

"inally Noah missed another important conservative position, or more precisely libertarian position: that the Fed’s accommodative monetary policy fueled the bubble and caused the crisis. That’s 100% right and the most important lesson that hasn’t been learned. "

That's actually almost 100% false; Brad DeLong did the numbers on his blog, to show what interest rate changes alone would have done to housing costs.

"There is one fundamental factor that affects housing prices and boosts demand but that doesn't have a (first order) effect on rents: the interest rate. When interest rates go down, the same mortgage payment supports a greater amount borrowed, and homebuyers can mobilize more (current) buying power without pushing closer to the margin on their (long-run, future) income."

"A 30% rise in local housing prices in a year in which short interest rates have not fallen and the yield curve not flattened is hard to explain as anything other than a bubble. But I still don't see the housing bubble as covering enough of the nation to be a danger.

"what does DeLong's real-time assessment of the risks posed by an asset bubble even have to do with Keynesian economics?"

About as much as predictions of hyperinflation have to do with Austrian economics and theory. In other words: not very much. As you have probably read, Noah frequently cites the lack of hyperinflation as evidence of the wrongness of the entirety of Austrian economics, in spite of the facts that:

1. Not all Austrian economists predicted hyperinflation. The most prominent one to do so was Bob Murphy, who famously lost a bet (to David Henderson, hardly a Keynesian). [And Peter Schiff isn't a professional economist.] Also, no economists from the "Free Banking/GMU" wing of the Austrian school (as opposed to the "Mises Institute/Auburn" wing) predicted imminent hyperinflation either.

2. Hyperinflation has relatively little to do with Austrian economics as a whole or Austrian Business Cycle Theory specifically.

**Because honestly, John S, what you're up to on this thread looks less to me like constructing logical arguments and more like performance art salad. So by all means, show me that when you speak about the world, you do so with care.

You are correct. I should not have written the word "frequently." However, I think it's fair to say that Noah strongly believes that the lack of hyperinflation predicted by some Austrian economists is a huge strike against the Austrian school and means that Krugman and DeLong have thus emerged as the early "victors" in the macrowars.

Noah wrote on 2/21/13: "Austrian econ is in full hysterical retreat mode, getting smashed on every issue." https://twitter.com/Noahpinion/status/304661418886717442

I'm really not sure what Noah means by "every issue"; I can only assume it's hyperinflation. If he means something else, perhaps he can clarify. Furthermore, he later re-tweeted a post by Cullen Roche specifically stating that the lack of hyperinflation has struck a mortal blow against the Austrian school. Given how much Noah has attacked the "hard-money coalition," I can again only assume that Noah agrees with Roche.

https://twitter.com/Noahpinion/status/359193635562074112

However, I fail to see how the mere non-appearance of hyperinflation makes Krugman/DeLong the winners** (as DeLong claimed here: http://delong.typepad.com/sdj/2012/12/when-will-robert-murphy-conclude-that-he-just-does-not-know-what-he-is-doing.html) and Austrians the losers in "hysterical retreat mode" since the winner of the hyperinflation bet with Murphy was David Henderson, an extremely pro free market economist who is himself highly influenced by Austrian economics (http://econlog.econlib.org/archives/2012/12/my_inflation_be.html). Additionally, Steve Horwitz, a bonafide Austrian, also agreed with Henderson! So when a non-Keynesian and another Austrian also predicted no hyperinflation, how does that make Krugman the undisputed winner?http://consultingbyrpm.com/blog/2012/12/murphy-inflation-smackdown.html#comment-54232

**In fairness to Noah, he made a great point in his subsequent "Krugtron" post about how Japan/Richard Koo has influenced Krugman's thinking. But that hardly seems like reason to declare Austrian econ as a "mostly dead paradigm" as he did in this post: http://noahpinionblog.blogspot.kr/2013/07/do-inflationistas-really-believe-what.html.

The main things I want to say are that, while I think debt-deflation/balance sheet recession thinking does indeed have a lot to tell us about the crisis, that still doesn't take away from the Austrians' main point: that the Fed's low rates may well have provided the primary fuel for the housing boom. And I hardly think that Murphy's lost bet and Peter Schiff's wailings totally discredit the Austrian school (which Noah often disparages; do I really have to list the links?), which has contributed quite a bit to monetary economic thought: http://www.freebanking.org/2013/07/13/what-we-have-done-for-you-lately/

I like the phrase "performance art salad." But who would I be performing for? Only a tiny subset of econ nerds even read the main posts--who actually reads the comments 2-3 days after? :)

But honestly, I do care about understanding the econ situation in the world today. I think the different factions of the econosphere are onto part of the story (like the proverbial 5 blind men and the elephant): market monetarists, GMU Austrians, balance sheet recession/debt-deflation guys, and Post-Keynesians. The two groups that come out worst in my view are: Mises Institute Austrians and "fiscalists."

Thanks for the thoughtful reply, John. So, yeah, I say "performance art salad" because I think you're throwing in too much stuff that doesn't support your main point. The stuff about Robert Schiller and average people not understanding the idea of real interest rates is a good example. I don't think that advances your argument one bit.

You appear to be saying that easy money via low interest rates was the main culprit behind the housing bubble, AND you want to credit the 'Austrian school' with this insight. Well, first, it isn't obvious that the Fed & Fannie & Freddie are to blame for the bubble. And second, in trying to defend Austrian thinking you point to some who did NOT predict "hyperinflation." (Aside: why do you keep saying hyperinflation rather than simply inflation? Are you trying to shield more Austrians from error?!) But are you fairly evaluating the Austrian school as a whole, or are you just cherry-picking the few who happened not to be so grossly incorrect?

I think a problem for Austrian/hard-money types is their obsession with price stability at the expense of employment levels. The Fed has TWO jobs, not one. Price stability is one job, maintaining full employment is the other job. Are you and other Austrians putting price stability ahead of full employment? It certainly appears that way to me.

Another problem for Austrians is the idea that markets basically cannot be improved upon so they shouldn't be interfered with. Well, this often winds up in the credulity-straining habit of excusing market failures as the fault of the government. And a lot of people think this is infantile. If markets are so wise, why can't markets adjust to government policy? And when something goes wrong, why is it necessarily the governments fault?

Thanks for the definition, Matt! Now I have a new term for my lexicon.

Re: Shiller--I actually think that he says some things that do apply quite well to Austrian, monetarist, and debt-deflation thinking re: boom/bust cycles.

Since the late 90s he has promoted the use of a CPI-indexed unit of account for denominating long-term debt contracts. Briefly, this would partially help to solve two problems: 1) money illusion (the public's inability to distinguish btw nominal/real changes); and 2) debt-deflation (since in recessions, NGDP/income growth is stagnant while nominally-fixed debt payments become more burdensome in real terms).

Perhaps to you this seems only tangentially related to what I said w.r.t. Austrian business cycle theory, but I think the issues are highly linked. Even if you don't give whit about anything "Austrian," I think the following links are well-worth reading:

You appear to be saying that easy money via low interest rates was the main culprit behind the housing bubble

This is a subtle, tricky question: was it easy money, int rate distortions themselves, or a combination? The "right," broadly defined, can't reach a consensus (but truly, no one fully understands the relationship btw monetary policy and asset prices). Scott Sumner maintains that bubbles cannot exist at all, since the market efficiently processes all of the information nearly instantaneously (rational expectations). George Selgin (GMU Austrian) argues that short-run interest rate deviations from the natural Wicksellian rate can alter the flow of spending in a way that artificially boosts asset prices. Larry White, as mentioned above, emphasizes that consumers can be fooled by low short term rates into taking on more debt than they can handle in the long-term (e.g. ARMs with low teaser rates). And David Beckworth, influenced by Selgin, argues that there was a global productivity surge in the late 90s/early 2000s of a sort which (in retrospect, and in the future) should lead the Fed to tighten monetary policy accordingly.

By this point, you may be saying, "Enough with the kitchen sink!" But what can I say? This really is a complicated issue, and all of these arguments deserve further evauation, which is why I was somewhat disappointed that Noah did not address the "low rates ---> housing bubble" argument in this post (as for its "conservative" credentials; John Taylor, Thomas Sowell, Ron Paul, the "End the Fed" movement, and the Mises Institute Austrians--figures or groups generally considered part of the Right--all made this argument).

I think it's quite clear that central bank interest rate manipulation, rightly or wrongly, lies at the heart of Austrian business cycle theory (which, I might add, is itself only a part of Austrian thinking as a whole). No other business cycle theory I know of places such emphasis on interest rate movements and the structure of production (although I believe more emphasis needs to be placed on low interest rates and consumption, particularly of durable consumer goods, as Vernon Smith mentions here: http://bigthink.com/videos/what-would-hayek-say).

Here is one formulation of ABCT, by Roger Garrison: http://www.youtube.com/watch?v=zhoFOyy7rbo

We agree!! But I notice you didn't mention the private markets for MBS's and CDO's. You know, like most things, financial markets are double-edged swords. Mortgage-backed securities, by attracting capital to the mortgage market, made home loans cheaper (without any role for the government.) But when the market for MBS's started warming up, the demand for them put downward pressure on lending standards. Again, the government had little or nothing to do with this, except perhaps insofar as the regulatory role was too often laughably enforced. But that is a problem of too little gov't not too much.

I notice that Beckworth wrote this:

To be clear, I do not see the Fed as the only contributor--far from it--but it does appear to be one of the more important ones.

I think Mark Thoma, for example, would agree with this. Low rates from the Fed certainly would have helped the housing market. That was the point! Because the Fed is not just looking at inflation, but also unemployment levels, ie, the general health of the economy. And it is a balancing act.

But if you consider what Beckworth said, it's clear that there is a broad range of interpretation consistent with his words. "One of the more important ones."

You bring up good points, which really forces me to do my homework (this is one reason why I enjoy having these types of discussions).

Let me first revisit your previous post and continue my response.

it isn't obvious that the Fed & Fannie & Freddie are to blame for the bubble.

No, it isn't obvious. But Beckworth et al make reasonable arguments that the Fed's policies were a major factor in blowing up the bubble and allowing the collapse of NGDP after the crash (i.e. leaning with the wind in both cases).

[Re: Beckworth's quote about the Fed not being the "only contributor"--in the intro to "Boom and Bust," while he acknowledges the importance of factors like "poor governance," he writes on page 1: "These essays conclude that the wide swings in the economic activity could not have occurred without the destabilizing policies of the Federal Reserve." In other words, in his opinion, the other factors were necessary, but destabilizing Fed policy was the sufficient condition.]

Re: F&F--I think there is some misunderstanding about my position. In the previous comments, I was responding to Noah's assertion that F&F likely did not play a major part in the crisis since they existed w/o major problems for many decades. I merely wanted to point out that regulatory changes in the 1990s, combined with F&F's much greater prominence in the mortgage market, made the F&F of the late 90s rather different entities than they before. Whether or not such changes were directly related to the housing boom is something I don't know and would like to investigate further.

Undoubtedly, as you mention, actors in the private sector (IBs, hedge funds, mortgage originators) played the dominant role in the overheated MBS/CDO markets. The question is why. More on this in a bit.

why do you keep saying hyperinflation rather than simply inflation? Are you trying to shield more Austrians from error?!

No ulterior motives here, Matt. Many of the articles/bloggers attacking Austrians for wrongly predicting high inflation following QE (such as Roche's piece above) use the term "hyperinflation" (although Bob Murphy's bet was actually on a 10% CPI rise). Perhaps they use the term b/c it sounds more exciting. Anyway, I'm happy to use the term "inflation" (or a specific number, like 10%).

are you fairly evaluating the Austrian school as a whole, or are you just cherry-picking the few who happened not to be so grossly incorrect?

I think I'm being fair. As I have mentioned to Noah before, the Austrian school today is divided into two main wings: Auburn (Mises Institute) and GMU (freebanking.org, coordinationproblem.org). The differences aren't minor. As one example, the Mises Institute Austrians generally consider fractional reserve banking to be fraudulent (a strange and historically indefensible position), while GMU Austrians do not.

The GMU Austrians publish regularly in academic journals and are much more in touch with "mainstream" economics. Overall, they are just superior monetary economists, imo. So I don't think I'm cherry-picking; I'm saying GMU guys were innocent of failed inflation predictions. To my knowledge (I may be wrong), no one on the GMU side (Larry White, George Selgin, Steve Horwitz, Mario Rizzo) made any predictions of imminent, above avg inflation, while Bob Muphy (Auburn) did make the bet on 10% by 2013. In fact, Peter Schiff is the only person I know of who said anything about "hyperinflation," and he isn't even an economist, so I'm not really quite sure what the hubbub of failed Austrian predictions is all about.

[I'm sure a few other Mises Institute guys were predicting high inflation, but I can't recall anyone in particular.]

The Fed has TWO jobs, not one. Price stability is one job, maintaining full employment is the other job. Are you and other Austrians putting price stability ahead of full employment?

[Note: From here on, when I say, "Austrian," I will be referring to GMU Austrians.]

I think Austrians believe both aspects of the dual mandate are flawed. Austrians oppose having a central bank at all, but given the fact that we do have a central bank, the current Austrian thinking is that the appropriate target is nominal GDP growth, i.e. maintaining the total flow of nominal spending in the economy, rather than an inflation target.

Here's Steve Horwitz (via Scott Sumner's blog):

"NGDP targeting is superior to price-level or inflation-rate targeting because it takes account of changes in real growth by using NGDP rather than just the price level. In that way, it is much closer to monetary equilibrium, although most defenders of NGDP targeting would want to target a growth rate in NGDP, while monetary equilibrium, strictly speaking, would mean targeting a value of NGDP. Offsetting changes in money demand with changes in the supply would lead to a constant NGDP. In either case, however, both price-level and real-growth changes are accounted for."

http://www.themoneyillusion.com/?p=20529

The problem with inflation targeting, according to both Market Monetarists and GMU Austrians, is that it doesn't take into account real GDP growth. Let's say the Fed adopts a yearly 5% NGDP growth target. If real GDP growth is good, say 4%, the inflation targeting portion of the NGDP target will be only be 1%. If real growth falls, say to 1%, the inflation target will pick up the slack and rise to 4%. In either case, total nominal spending is maintained at a predictable level (thus preventing increased real debt burdens, such as fixed mortgage payments).

Under a 2% inflation targeting regime, during the boom period, NGDP would grow by 6%, while it would only be 3% in the down period. These swings in NGDP are--according to the theory--major contributors to boom/busts cycles.

These ideas are summarized by Scott Sumner here: http://www.themoneyillusion.com/?p=20599

Re: employment targets--both Austrians and MMs don't believe it's a good idea for the central bank to target real variables. As far back as Milton Friedman, many economists have warned central banks not to overestimate their ability to permanently lower the unemployment rate beyond the natural/structural unemployment rate.

Here, Austrians show that they aren't simply MM clones, b/c they also focus on the potential of monetary policy to cause asset boom/busts, such as the housing boom, which certainly aren't desirable.

And how do you define "full employment"? Is it the unemployment rate? Or is it the employment-to-population ratio (a more relevant measure, imo)? The former is problematic, b/c labor force participation rates are dropping, but restoring the latter to it's former, pre-crisis level might well be impossible.

Daniel Kuehn has some good comments on this here: http://factsandotherstubbornthings.blogspot.kr/2012/08/labor-market-indicators-continued.html

I think the best summation of the Austrian perspective on monetary policy, at least w.r.t. the MM position, is this comment by George Selgin on David Glasner's blog:

"Finally, it's quite incorrect to assume that to assert that there’s merit to the Austrian view is to deny that busts can also be caused by monetary contraction–as if the Fed and other CB’s weren’t capable both of encouraging booms with overly easy money and of contributing to busts by making money overly tight. A man is rescued from drowning, his lungs full of water. He is revived, but then given nothing to drink. Must we say of such a man either that he is suffering from having taken in too much water, or that he is suffering from taking in too little? Can we not say that he has suffered first from one thing and then from the other?"

Why do you talk about targeting real NGDP and then say that Austrians don't think the Fed should target real variables? That is confusing.

Why do Austrians, and presumably you, think we would be better off without a central bank? Aren't you really saying, "let's bring back the 19th century!" The good old days.

Isn't the gist of your position a severe pessimism about human capability? "It can't be done," that's my take away from the Austrians. But if you look around you'll see mind-boggling evidence that people are capable of truly amazing achievements and many if not most want to see human ingenuity used for the benefit of all. We did put a man on the moon, you know, unless you think that was a hoax.

Apologies for the delay in responding, Matt; been busy. I'll continue to post periodically in this thread as time permits.

Another problem for Austrians is the idea that markets basically cannot be improved upon so they shouldn't be interfered with.

This idea about the efficiency of markets is shared by most mainstream economists as well as the "First Theorem of Welfare Economics." [Aside: Are Austrians part of the mainstream or not? I would say yes, they are indeed part of the neoclassical tradition.]

Unlike most economists, who aprioristically assume the necessity of a central bank and govt produced money, Austrians believe that free markets--voluntary exchanges and contractual agreements--would work (and have worked historically--with a possible exception of Australia in the 1890s--in Canada, Scotland, and some of the US states) in the realms of banking, credit, and money. You can peruse some of the Austrian research on such systems in the book, "The Experience of Free Banking":

this often winds up in the credulity-straining habit of excusing market failures as the fault of the government.

As I have stated, some economists (both Austrian and non-Austrian) see the subprime crisis as a failure of Fed policy which distorted market incentives. For example, in Diego Espinosa's chapter in Beckworth's "Boom and Bust," he argues that by explicitly stating its intention to prop up asset prices and indefinitely maintain low short-term int rates (a change from previous Fed behavior), the Fed in the first half of the 2000s set up the ideal, enabling conditions for a massive and highly leveraged carry trade (i.e. borrowing cheaply at short-term rates and investing in higher yielding long-term assets such as AAA-rated CDOs/MBSs).

By promising not to raise rates, the Fed inadvertently protected speculators from the risk that rates might rise (and devalue their long-term holdings). Espinosa also points to other ways the Fed lessened the risks for speculators (e.g. by promising to ease, thus ensuring liquidity for long maturity assets, and by promising to support asset prices, lessening the risk of credit downgrades of these long-term investments). This chain of events set in motion by Fed policy, in Espinosa's view, is what drove the financial system to manufacture more AAA-rated assets to fuel this carry trade, which in turn led to lowering of lending standards and soaring home values, which further boosted the vicious cycle.

So the market did indeed adjust to govt policy, but not in the way the Fed intended--another example of the well-known economics principle of "unintended consequences."

http://www.econlib.org/library/Enc/UnintendedConsequences.html

(Besides the subprime crisis, can you give me some other examples of things you consider to be "market failures" that Austrians have habitually blamed on the govt?)

I do not have a dogmatic position that "market failure" is an impossibility, and we should have no regulation at all. But until such failure can be proven to a reasonably high degree of certainty, I think it's best to avoid assuming the necessity of govt interference. In my view, the null hypothesis should be that free markets work best. (Also, I dislike framing the question as "regulation vs. de/re-regulation." We have to talk about specific regulations/policies, not "regulation" as an abstraction).

If markets are so wise, why can't markets adjust to government policy?

You could ask this question about any number of govt policies. If the govt suddenly raised tariffs on oil imports by 20%, certainly markets would adjust, and a new short-term equilibrium would be reached. But would such a policy be optimal? (Almost all economists would say no; consumers would lose, and domestic producers would unfairly benefit). The same can be said of well-worn Econ 101 examples of govt interventions that most economists oppose: rent-control, agricultural price supports, and minimum wages.

The fact that markets can "adjust" in response to any policy doesn't mean that we shouldn't question whether those policies are flawed or not (as Beckworth's Boom and Bust does w.r.t. to Fed policy in the 2000s-now).

One more point: underlying market conditions are constantly changing as well, not just govt policies. But this is indeed a key Austrian principle: according to Austrians (most famously Hayek's "tin" example), market driven changes in prices embody information about underlying conditions, which enable market actors to make better decisions. In the Austrian view, govt policy choices have a far more tenuous connection to market conditions and are more likely to reflect the motivations of politicians, their constituents, and special interest groups who supported the policy.

And when something goes wrong, why is it necessarily the governments fault?

I don't believe this. But before conclusively declaring a given situation as market failure, I think it's best to first examine the possibility that there may be govt failure.

"Stimulus can't work, because it's just moving demand from one part of the economy to another."

I've never understood this argument. Doesn't the same logic 'prove' that private spending decisions also can't have macroeconomic impact, and that the state of the economy is thus totally independent of decisions made by economic actors? The moment you don't artificially restrict the argument to the government it yields absurdity. Unless I'm missing some subtlety...

the problem with the "CRA caused the crisis" argument isn't just that the CRA has been around since the 1970s, and the bubble grew post-2002, it's that the CRA does not apply to non-deposit taking institutions. So all the independent mortgage lenders (Countrywide, etc.) simply are not governed by it. It just doesn't apply to them. Saying their actions were caused by the CRA is like saying some alters their driving habits because of the requirements for a pilot's license (even though they have no intention of ever flying a plane).

The data on this are really clear. The vast, vast, vast majority of the subprime loans were not made by CRA-governed institutions. For reference, take a look at William Apgar at the Joint Center for Housing Studies at Harvard, or Dan Immergluck in Urban Planning at Georgia Tech, or Elvin Wyly in Geography at the University of British Columbia, or Kathe Newman in Urban Planning at Rutgers (and many, many more -- I'm just picking the researchers who have been analyzing this data for many years, and knew how bad those loans were and what was going on in American metropolitan areas as early as 2003...)

It seems to me that even for the deposit taking institutions that were subject to the CRA - once they had the mortgages they packaged the mortgages into MBS and CDO products and sold them. No one forced the buyers to buy that stuff and without a market for the pooled mortgages the bubble would not have happened. Whether the sellers were fraudulent or the buyers were incompetent there was a serious failure among sophisticated financial players. When PIMCO looked into investing in MBS they backed off after realizing all the problems with mortgage origination, so the problems were there to be seen and acted on.

"The infrastructure spending we need to be doing could be financed by tax hikes and cuts in transfers, to the benefit of all."

Umm, that's pretty clearly not true. For example, if you are receiving Social Security, there's absolutely no way that cutting your Social Security payment to pay for, say, a high-speed rail line benefits you: Sure, you might reap part of the benefit of having that rail line, but the cut to your SS check would almost certainly be greater than the value of access to that rail line.

So a more accurate statement would be that this could give us a net societal benefit, but at a cost to those who lose transfer payments or are taxed at a higher level.

Too bad you didn't use home ownership rates. That would effect supply and demand. 1995-2000 they rose from 64% - 67% the largest gain since 1965. 2000-2005 they rose from 67%-69%. Guess it was more convenient to use income ratio when after the crash it was determined many incomes were inflated, giving a skewed number to be useful in a skewed arguement.

Second the anon above who wonders why the "stimulus doesn't work because it's just moving money around not creating growth or anything new" holds any traction. Why would tax cuts then help? It's just taking money the government's using and giving it to taxpayers to consume with,to follow that slow, rusty train of thought.

Response to the counterargument to arg # 1 - The international financial system is linked to the point that when a Swiss investor loses value in his mortgage backed security tied to a Las Vegas suburb, he is going to have less cash to invest in that new Spanish apartment (the location or the film). The argument is, I believe, that the scale of the US asset crash sparked the liquidity crisis that led to worldwide recession. However, I'd be very curious to read any materials on the order of how things played out. I have a basic understanding of how it happened in the U.S., having worked in the financial sector in time in a regulatory role, but not so much how it happened abroad.

Noah, your posts are of a tribalist person convinced of their own narrative trying quite pathetically 'to examine' his views to pretend to himself and others about objectivity, and this makes if nothing else an interesting sight.Though it is not much different than most trite of tribalists, partisans and other wonderful persons who lack critical thinking abilities. Well they have just enough to more strongly convice themselves of their superiority and manufacture strawmen or focus on the worst positions, and too little for any actual objectivity. And do this by focusing on insufficient evidence and insufficient examination of the opposite view. So maybe it is not that unique. You are just more famous and also like more to pretend to give others 'a fair chance'. Though it is kind of transparent that it is a pretension.

And no, I am not consevative or libertarian or austrian or communist. Not exactly liberal either though I would describe myself more liberal than not.

I think that some different groups have certain right points that fanatic tribalists refuse to aknowledge and like to create strawman versions of their opponents or focus on the arguements more easy to strike down or the worst or distort facts than awknowledge aspects of those different beliefs which are correct or just focus on team a vs team b kind of thinking. Because why examine your own views and whether there is anything true in what others are saying when you can just focus on a false dillema of a bad package of views vs your package of views, so you can bring support in your team. It is not an issue about fallacy of balance but about conclusions out of examining actual facts that no are not only found in the liberal side and also examining people who are obviously playing team games such as you demonstrated repeatedly.

Of course the purporse of this post is to not examine the obvious but bash you and everyone else who thinks like you and their purporse as a political comentator and economist is not to reach truth but stroke their e-penis and play theirselfs as great over their horrible (in their delusional minds) enemies. Playing the role of what is the pathetic and disgusting creature that is the politician over the scientist economist which actual scientists (but not many economists) don't do.

Something that your friend Krugman likes very much to do.

The nature of economics is limiting but certainly there is more room for truth and more intellectually honest economists that are less concerned with bashing the opposite team. But no I don't think there is any hope for you. You are happy being the tribalist who pretends that reality always agrees with you and not with those bad other people. Which also sells a lot towards the many, many like-minded people.

Note that if you changed your team and badly examined the opposition, not much would change. In fact, many in the opposite team share their awfulness with people like you, their ideological opposite, and they share that awfulness in most things, including in how a tribalist views team A vs team B.